Utility Week

UTILITY Week 31st March 2017

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UTILITY WEEK | 31ST MARCH - 6TH APRIL 2017 | 17 Finance & Investment Analysis B ack in 1989, when the ten water com- panies were on the privatisation block, Thames Water aspired to be in a league above its nine country cousins, including Severn Trent; indeed, Thames was floated on the lowest yield of the ten companies. However, despite its customer base of 15 million in London and neighbouring coun- ties, subsequent years proved far less pro- ductive for Thames. Aer six years of ownership by German utility RWE – whose star has also waned – Thames ended up being acquired in 2006 by a consortium of private equity investors, led by Australia's Macquarie. Although Macquarie has now sold its 26 per cent stake in Kemble, Thames's parent company, it remains a major UK infrastruc- ture player through its ownership of stakes in power stations, water companies, the M6 toll road, airports and the Arqiva radio masts and mobile communications business. From time to time, Macquarie recycles its asset base and this partly explains its exit from Thames. Moreover, with substantial UK invest- ments undertaken over the past two years, not least as a member of the winning consor- tium to buy the 61 per cent stake in National Grid's gas business, the proceeds from the Kemble disposal will certainly come in handy. It is also, more controversially, seeking to buy the Green Investment Bank, which the government is privatising; this deal still has to be completed. The buyers of Macquarie's 26 per cent stake in Kemble are the Toronto-based Bore- alis – part of the wealthy Ontario Municipal Employees Retirement Scheme (OMERS) – and the Kuwait Investment Authority, a long- established sovereign wealth fund. Like Macquarie, Borealis is a well-known international infrastructure asset investor; it has built up key stakes in both Associated British Ports (ABP) and the HS1 rail link to Paris. Less successfully, it was a spurned bid- der for Severn Trent. Canada avoided much of the financial carnage associated with the 2008/09 credit crash that engulfed much of Wall Street and many leading UK and EU financial institu- tions, and its financial services sector has prospered in relative terms. Borealis, like Macquarie, fully recognises the attractiveness of long-term, stable rev- enue streams that can be deployed to finance long-term pension liabilities: UK water com- panies fit this bill perfectly, although certain assumptions about the impact of future peri- odic reviews are necessary. In terms of the price paid for the 26 per cent stake in Kemble, the rumoured figure is £1.35 billion, which – if accurate – would suggest a healthy premium over Thames' reg- ulatory capital value (RCV) of £11.9 billion, once the hey net debt element has been stripped out. Furthermore, a smaller Canada-based investor, Fiera – via its Aquila subsidiary – has also acquired a stake in Kemble; it paid £120 million for a 2.4 per cent shareholding. And Australian-owned Hastings Funds Management has recently secured full ownership of South East Water, implying a total equity valuation of £400 million for the business. Of course, in terms of utility RCV premia paid, it is the eye-watering National Grid gas division sale – or at least 61 per cent of it – that implied a stonking premium over the £8.5 billion RCV. Many analysts were expecting successful bids valuing the business at over £11 billion. However, the Macquarie-led consortium pushed out the boat and agreed an indicative valuation figure of £13.8 billion; this implied a very aggressive premium to the RCV. The days of a 30 per cent premium for a utility stock being par look numbered. Assuredly, the Borealis-led consortium will have made various assumptions about how Thames will fare in the next periodic review, which is due in April 2020. Despite some threatening noises from Ofwat, the reality is that the pivotal weighted average cost of capital (Wacc) assumption will probably rise, in nominal terms at least, on the back of higher global interest rates; as expected, the US Treasury has just confirmed a quarter-point increase. However, the risks associated with the £4.2 billion Thames Tideway Tunnel (TTT) scheme – previously seen as a heavy liability for Thames – have abated, with Bazalgette Tunnel taking control of the 16-mile super- sewer project. Increases in Thames' bills will partly finance this expensive – and controversial – scheme, but the risks for its sharehold- ers seem to have been markedly reduced, although the funding arrangements associ- ated with the TTT project are complicated. Even so, Thames still has an ongoing £4.5 billion five-year capital expenditure to deliver by March 2020. Much of the construc- tion work will take place in very busy and built-up parts of London, so this remains a formidable challenge. More generally, stock markets have boomed following the election of President Trump. Furthermore, the pound sterling, which plunged aer the unexpected Brexit result last June, has made UK corporate stocks look comparatively cheap. This view has been endorsed by the take- over of ARM Holdings and the abortive bid for Unilever, along with corporate activity in the oil services and building sectors; in the latter, there is a scramble to acquire Bovis. Hence, further activity in the utilities sec- tor should be expected, ranging from out- right bids or the exchange of assets owned by private equity share-holders, such as the recent deal involving Thames. Nigel Hawkins, director, Nigel Hawkins Associates Macquarie checks out Australian bank Macquarie has sold its stake in Thames Water's parent company and is seeking new infrastructure investments. Nigel Hawkins surveys the landscape for investors. Key numbers 26% The stake in Thames Water that Macquarie has sold. £1.35 billion The price rumoured to have been paid by the Toronto-based Borealis. £120 million The amount paid by Fiera – via its Aquila subsidiary – for a 2.4 per cent shareholding.

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